Politics, rather than central banks, likely to take centre stage for now; but with much potentially hanging on the mercurial temperaments of Trump and UK voters, it’s anyone’s guess what the coming weeks hold.
Trade negotiations threatening to drag on
Financial markets fluctuated on headlines with respect to a potential US-China trade deal during the course of the past week, but were ultimately little changed.
Credit markets have followed the lead from equities over the past week. The OPEC meeting was a focus of attention for the energy sector, though for now we continue to see oil prices trading in a range.
Robust PMI surveys lifted global growth hopes and bond yields towards the start of the week, though the lingering threat of a tariff extension on 15 December threatened to overshadow this more constructive news.
We believe that additional US tariffs are unlikely to be enacted at this point, though we are inclined to believe that trade negotiations will drag on into the New Year with additional tariffs postponed pending the outcome of these talks.
In this context, we believe that a risk-off move is a possibility and are wary that seasonally thin markets could easily be pushed around by non-substantive news headlines. A trade breakthrough could similarly provide the catalyst for a year-end rally, yet we do not see any particular pressure to bring discussions to a rapid conclusion.
Away from this noise, additional fiscal stimulus in Japan attracted some headlines over the past several days. We see this confirming our view that the Bank of Japan is unlikely to ease policy further, in order to counter any downside risks to growth, with fiscal policy needing to be utilised as the extent of monetary policy is reached.
We believe that a similar narrative also holds true in Europe, but here steps towards fiscal easing are only progressing very slowly.
Changes at the head of the SPD in Germany may make a new election more likely in 2020. However, for now, an election outcome that sees a black/green coalition would probably see Annegret Kramp-Karrenbauer (or AKK as she is referred to) as the next German chancellor.
Given AKK’s fiscally hawkish stance to date, it seems that Berlin may be reluctant in moving away from the schwarze Null (or ‘black zero’) policy dictating the need to deliver a balanced budget. A red/green coalition would be more open to a more expansive fiscal policy, but with the SPD polling poorly, the likelihood of such an outcome continues to appear relatively unlikely for the time being.
London calling (for more easing)
By way of contrast, we see the UK racing towards fiscal easing, relatively speaking. Having seen an expansion in government spending already in 2019, we expect further policy easing regardless of the winner of the upcoming general election, which will take place next week.
In our view, this means that the Bank of England is unlikely to need to lower cash rates further – and with 10-year Gilt yields flat to cash rates, we see materially more scope for yields to rise than to fall.
Focusing on the election itself, it appears that markets have convinced themselves that Boris Johnson is on track to win a solid majority for the Conservative Party. We continue to see this as the most likely outcome, though we believe that there may be complacency around this view.
In reality, there remains a large number of close marginal seats, which could be decided based on the turnout levels and any inclination towards tactical voting in the British first past the post system. Consequently, we continue to attach a probability of close to 30% that the Tories fall short and consequently have seen current levels below 0.845 as, we believe, an attractive level on our long sterling view ahead of next week’s vote.
No singular view in emerging markets
In emerging markets, economic woes in South Africa have seen the state need to step in to support the domestic airline SAA.
We see a global backdrop of relatively stable yields and trend US growth creating a benign backdrop for assets offering positive carry, yet it remains difficult to adopt a singular view on emerging-market (EM) beta, with country specific factors driving a relatively heterogeneous set of outcomes across different countries within the EM universe.
We remain bullish on carry plays such as Russia, where rates are high and the policy mix remains supportive. Local assets in Mexico also appear attractive on carry and as we look for USMCA (free trade agreement) ratification before the end of the year, this could serve to deliver a boost to the Mexican peso.
By contrast, South Africa, Turkey and South Korea are just three of the names in which we have a more negative view, and so we find ourselves expressing an outcome in which we adopt relative-value positions across EM.
Playing the guessing game
Looking ahead, we have US payrolls later today, the Federal Reserve and European Central Bank (ECB) meetings in the middle of next week, and then the UK general election at the end of the week.
It is fair to say that this represents an action-packed agenda, given the time of year – especially when one throws in the looming deadlines on the China tariffs, plus the likely House impeachment of Trump, which may also conclude in the next two weeks.
In many respects, it seems that the central bank meetings are likely to take a back seat to the politics, with no change in messaging expected from either Powell or Lagarde at the FOMC and ECB press conferences.
In this context, much may hang on the attitude of Trump and of UK voters in the coming few days. Maybe Baby Yoda could read the minds of these unpredictable creatures … but for us mere mortals, a guessing game it may be. With that being the case, sitting on our hands seems like the smart thing to do for the time being!